It’s highly unlikely that the collapse of Lehman Brothers (NYSE:LEH) and sale of Merrill Lynch (NYSE:MER) marks the end of the credit crisis. There is still $1 trillion in at-risk Alt-A mortgage debt out there and an even bigger amount of money tied up in credit derivatives. It’s only a matter of time before investors realize that US Treasury bonds are the biggest bubble of them all, says Dan Denning.

This from The Daily Reckoning Australia:

How many pundits are going to call the bottom with a Lehman liquidation? A lot, we’d guess. But they’ll be early. There are still two big remaining bastions of funny money from the credit bubble. Three, actually.

One is in the Alt-A mortgage market. Bloomberg reports this weekend that Alt-A mortgages originated in 2006 an 2007 are already showing markedly higher delinquency rates than even submprime loans of the same vintage. Yet the Alt-A buyers were supposed to be lower credit risks (How this was established is a mystery, since many Alt-A loans were made without any documentation of the buyer’s income, or, without right exaggeration in said incomes.)

Now, of course, the whammy has tripled. Home prices are falling. Payments on option ARM loans are increasing (as the interest is added to the principal, meaning the new loan value is anywhere from 110% to 120% of the original value). And that exaggerated income? It remains what it always was, a fiction.

So there are US$1 trillion in Alt-A loans on the books of companies like Wachovia (NYSE:WB), Washington Mutual (NYSE:WM), Fannie Mae (NYSE:FNM), and Freddie Mac (NYSE:FRE). The best case scenario is that the market has already priced in this second wave of housing destruction. After all, both Wachovia and WaMu are down massively (WM down 92% in the last year and WB down 70%). We know what happened to the GSEs.

But after the sea of bad debts from collateralized mortgages is drained, there is a whole ocean of other debt-related assets just over the horizon. Securitized credit card receivables and auto loans come to mind. Then there is the massive credit default swap market. And of course, the huge bubble in Treasury bonds.

Here’s a prediction: the liquidation of Lehman Brothers (NYSE:LEH) and merger of Merrill Lynch (NYSE:MER) may very well produce a further rally in the U.S. dollar and a gold price under $700. And then gold will have bottomed. Investors will gradually realise that U.S. bonds are the last great refuge of the credit fraudsters.

What then? Bonds sell off and resource equities and precious metals begin to rally from their current battered state. That’s what happens next. C’mon people! It’s basic Austrian economics! Or, as Roger Garrison of Auburn University puts it, “The misallocation of resources during the period of artificially cheap credit has the feel of genuine growth, but the good feelings are followed by bad ones.”

“The commitment of too many resources to projects that will yield output only in the remote future has as its counterpart an undue scarcity of resources for producing output in the near and intermediate future. With the passage of time, the misallocation becomes apparent, after which follows a period of liquidation and reallocation—in a word: a recession.”

What a contrast. A recession in the paper economy of America looks like a dead certainty. This fact has pushed all stock prices down to near bear-market lows and made resource shares very cheap. Yet these shares retain the ability to grow earnings on the back of strong trends in the real economy of the developing world. What’s not to like about that?

Source: Lehman Brothers on the Verge of Liquidation